Thursday, May 31, 2012

Push Comes to Shove, by Tim Duy: The Spanish banking crisis is forcing another showdown in Europe with the German-led Northern contingent increasingly under siege not just from the South but now from just about everyone else. Spain is under pressure to finance a bank recapitalization, but worries that that path will push them straight into a Troika bailout program. And we all know just how well that has worked for Greece and Ireland and Portugal. And Spain holds real leverage. No one is under the delusion (well, almost no one) that Spain can exit the Euro without significant economic damage throughout Europe. Hence we are seeing increasing pressure on Germany to step-up the timetable to real fiscal integration, starting with a Euro-wide banking rescue using ESM funds. From Bloomberg:

German Chancellor Angela Merkel was besieged by critics for letting the euro crisis smolder, with the leaders of Italy and the European Central Bank demanding bolder steps to stabilize the 17-nation economy.

Italian Prime Minister Mario Monti and ECB President Mario Draghi pushed Germany to give up its opposition to direct euro- area aid for struggling banks. Monti further antagonized Germany by urging a roadmap to common borrowing.

The idea is to let banks tap the funds directly without going through their respective national governments - thus avoiding another Troika bailout disaster. Germany, of course, continues to resist, as this would force them to give up one of their tools to enforce austerity throughout Europe. Perhaps, however, German Chancellor Angela Merkel is starting to break under the pressure:

Merkel put some nuance into the German position today. While promising “no taboos” in attacking the crisis, she floated a timeline of “five to 10 years” for fixing flaws in a currency shared by countries with divergent wealth and attitudes toward taxing and spending.

Of course, Europe doesn't have a 5 to 10 year horizon. I am thinking they have something closer to a 5 to 10 week horizon to get their act together. Something big is going to happen in Europe this summer, and I think the odds of a tail-end outcome are increasing, at both ends of the tail. Either Europe pulls together sooner than the German timeline, or finally blows apart. The middle-ground, muddle-through option looks less attractive each day.

Cash Exiting China, by Tim Duy: Something that I have thinking about for a few weeks - and was reminded of reading Ryan Avent this morning - is the series of pieces at FT alphaville regarding the outflow of cash from China. See here and here and here. The thinking had been that the renminbi was a one-way bet as China moved forward with capital account liberalization as investors rushed to be part of the Chinese story. The growing exodus of cash, however, is calling that story into question.

Moreover, I am interested in how much of the outflow is attributable to a generalized rush to safety as a result of the European crisis versus how much is attributable to capital flight due to a a deteriorating economic environment inside China itself. I am reminded of this story from the Wall Street Journal earlier this year:

With a fortune of at least $1.6 million, Mr. Shi is part of the wealthy elite that benefited most from the Communist Party's brand of capitalism. He is riding the crest of arguably the biggest economic expansion in history.

And yet, while the party touts the economic success of the "Chinese model," many of its poster children are heading for the exits. They are in search of things money can't buy in China: Cleaner air, safer food, better education for their children. Some also express concern about government corruption and the safety of their assets.

Domestic money in China will be the first to head for the exit - insiders will always know more than outsiders about the underlying economic conditions. So the exodus of cash could indicate that the Chinese story is coming to a close - and that will have significant consequences for the global economy. It is another signal that emerging markets will not be supporting global demand anytime soon. I think the team at alphaville is right - this story is slipping under the radar while we all have our eyes focused on the farce in Europe. But it could be the real game changer in the global economy.

The Economic Costs of Fear, by Brad DeLong, Commentary, Project Syndicate: The S&P stock index now yields a 7% real (inflation-adjusted) return. By contrast, the annual real interest rate on the five-year United States Treasury Inflation-Protected Security (TIPS) is -1.02%. Yes, there is a “minus” sign in front of that: if you buy the five-year TIPS, each year over the next five years the US Treasury will pay you in interest the past year’s consumer inflation rate minus 1.02%. Even the annual real interest rate on the 30-year TIPS is only 0.63% – and you run a large risk that its value will decline at some point over the next generation, implying a big loss if you need to sell it before maturity.

That is an extraordinary gap in the returns that you can reasonably expect. It naturally raises the question: why aren’t people moving their money from TIPS (and US Treasury bonds and other safe assets) to stocks (and other relatively risky assets)? ...

Here are some old posts from here and elsewhere that provide rebuttal to recent rebuttal (mostly the usual hacks twisting the data to "prove" that government has expanded immensely under Obama). It would be better for the economy if spending across all levels of government had increased temporarily to a signficant degree, so this isn't necessarily a badge of honor. But nevertheless the charge that Obama has used the recession as an excuse to increase the size of government doesn't withstand an honest look at the evidence:

Paul Krugman:

The Secret of Our Non-success, by Paul Krugman: ... Look at government (all levels) purchases of goods and services, that is, actually buying stuff as opposed to transfer payments like Social Security and Medicare. Here’s the past decade:

Obama, far from presiding over a huge expansion of government the way the right claims, has in fact presided over unprecedented austerity, largely driven by cuts at the state and local level. And it’s therefore an amazing triumph of misinformation the way that lackluster economic performance has been interpreted as a failure of government spending.

Seeing the Krugman commentary comparing real government spending under Obama and Reagan made me curious about what it looks like if you express it in per capita terms? In particular, how does the Obama period compare with other presidencies in terms of penury/austerity versus spendthriftness?

To compare presidencies, I did the calculation two ways. One starts in the quarter before the president was elected (e.g., 2008Q4), the other starts in the first quarter of the presidency (e.g., 2009Q1). (The ARRA probably had some effect in Q1, but most of the change was simply economic conditions that the incoming president had nothing to do with, so I think I prefer the Q1 to Q1 method). Ranking since Johnson (starting in 1968), and using the first-quarter comparisons, and calculating growth under Obama through 2011Q4, Clinton is the most austere, followed by Obama. The most spendthrift are (1) Nixon-Ford, (2) Reagan, and (3) Bush II. The figure is pasted below:

The top (blue) line shows that private nonresidential investment has rebounded smartly since early 2009, when President Obama took office. Residential investment first dropped, and then mostly came back.

The real problem is government investment, which is down 8.3% since the first quarter of 2009, and still falling. In other words, government spending on infrastructure infrastructure, building, and equipment is declining, adjusted for prices changes.

This is just utterly bizarre. In a time when the economy is still sluggish, government investment should be the simplest thing to pump up. We need to modernize our infrastructure and bring government into the 21st century, and it’s just not happening.

Here’s another angle. This chart shows net government investment as a share of GDP.

According to this chart, net government investment is the smallest share of GDP in more than 40 years, and dropping.

Antonio Fatas:

Euro and US Coordinating Austerity, by Antonio Fatas: To add yet one more perspective on how significant the shift to austerity among advanced economies has been since 2009, I decided to add the Euro series to a chart from Paul Krugman's blog. This is real government consumption for both the US and the Euro (17 countries) area.

It is remarkable how the Euro area and the US display a strong coordinated contraction in fiscal policy starting in the first quarter of 2009 that accelerates during 2010 and 2011... No surprise that the recovery is not going as well as some thought and some countries are going back into recession.

The 15,000 additional jobs lost in April brings total job losses in the government sector since January 2010 to over 500,000. While the US has not quite been experiencing European-style austerity over the past two years, that's still a pretty tough headwind to fight as it emerges from recession.

Another one from Paul Krugman:

Four Fiscal Charts, by Paul Krugman: Here’s an exercise I did for my own edification... I wanted a simple answer to the people who always insist that we must be having massive fiscal stimulus because we have a big budget deficit; my answer is that the deficit is a result of the depressed economy...

Well, here’s a quick and dirty approach. ... First, most of the surge in the federal deficit is about plunging revenue. In the figure below, the “No recession” line shows what would have happened if federal revenue had grown 5 percent per year after 2007:

That’s about an $800 billion per year shortfall.

What about spending? Well, it is higher than you would have expected in the absence of the slump, by around $300 billion:

Income security spending is, of course, strongly related to the state of the economy. So are some other forms of spending — Medicaid, of course, but also things like disability insurance, where people on the cusp are more likely to seek the benefits if they can’t find work.

So basically, the federal deficit is all, yes all, about the recession and aftermath.

And meanwhile, there has been austerity at the state and local level (calendar years here instead of fiscal, but that’s not crucial):

So the reality is that we have deficits because the economy is depressed, but relative to previous policy we’ve been imposing fiscal austerity, not stimulus.

If this sounds familiar, it’s because we suffered through an identical performance last summer. Our analysis of that episode leads to a troubling conclusion: It almost derailed the recovery, and this time could be a lot worse. ...

High-frequency data on consumer confidence from the research company Gallup ... provide a good picture of the debt-ceiling debate’s impact (see chart). Confidence began falling right around May 11, when Boehner first announced he would not support increasing the debt limit. It went into freefall as the political stalemate worsened through July. ... Businesses were also hurt by uncertainty... This proved far more damaging than the regulatory uncertainty on which Republican criticisms of Barack Obama’s administration have focused...

Growth in nonfarm payrolls decelerated to an average 88,000 a month during the three months of the debt-ceiling impasse, compared with an average of 176,000 in the first five months of 2011...There are also more visible permanent scars. The sense that the U.S. political system could no longer credibly commit to paying its debts led the credit-rating company Standard & Poor’s to remove the U.S. government from its list of ... AAA ratings. ...

All told, the data tell us that a debt-ceiling standoff is an act of economic sabotage. ...

The next debt-ceiling battle could be worse, because the stakes are even higher. In addition to the threat of default, the U.S. is facing the so-called fiscal cliff... Another stalemate would almost certainly plunge the economy into a deep recession. Our best alternative -- in fact, our only hope -- is for Congress to set aside partisan politics and work together with a common goal of helping our country out of the Great Recession.

I wrote a column during the debt ceiling debate making many of these points, and it's nice to have more evidence to back them up:

The Real Cause of Economic Uncertainty: Prior to the midterm elections, Republicans made a big issue out of the economic uncertainty supposedly created by Democrats in areas such as health care reform, financial reform, future tax rates, the deficit, environmental regulation, and the long-run viability of our social insurance programs.

Even though there was little to suggest that uncertainty rather than lack of demand was the fundamental economic problem, Republicans were able to persuade many voters that this uncertainty was holding back the economic recovery and lowering long-run economic growth. Electing Republicans, it was argued, would help to eliminate the uncertainty and go a long way toward curing our economic ills.

Does anyone think that uncertainty has been reduced since Republicans gained a majority in the House of Representatives? I certainly don’t.

Let’s look at the record. Upon taking the House, Republicans began looking for ways to make good on their campaign promise to repeal health care reform. Whether they can actually do this or not isn’t clear – so long as Obama is in the White House veto power prevents major change – but even so, challenges in court, promises to cut the funds needed to implement the law, and vows to overturn health care reform at the first opportunity make it much more difficult for businesses and households to make long-run plans. Uncertainty has gone up, not down.

We’ve seen a similar attack on financial regulation. Conservatives have vowed to repeal as much of Dodd-Frank as they can, and to prevent any additional regulation. They have done everything possible to prevent the Consumer Financial Protection Agency from having any teeth, or existing at all, and they retain their misplaced faith that unfettered financial markets are the key to stability rather than an invitation for more problems. Again, precisely how successful they will be over time, and what the regulatory structure will look like in the longer run are uncertain, and it is more difficult than before for businesses to plan for the future.

Republicans have also vowed to privatize Medicare and Social Security, and to substantially reduce the scale of these and other social insurance programs. And, when given the opportunity, they have demonstrated this is more than campaign rhetoric. They intend to privatize and scale down these programs if there’s any way possible to do it, and to continue trying for as long as it takes. It’s hard to see how this increases the financial security of the elderly, the unemployed, and the unhealthy, or how it promotes a more certain economic environment.

And then there’s the biggest of them all, the fight over the debt ceiling. It would be bad enough to hold the nation’s future hostage over an ideological dispute in the best of times, but to do so at a time when we are struggling to recover from the most severe recession since the Great Depression, a time when millions and millions can’t find jobs and must rely upon programs Republicans are trying to cut, is unconscionable. And this is not the first time Republicans have done this. Remember when Republicans threatened to undermine the recovery if Democrats tried to raise taxes on the wealthy? It was a clear threat – if we don’t get our way, the economy gets it.

And the current threat is even worse. ... And think of the precedent this sets. In the future, we can expect more of this. ... How does that promote long-run stability?

There will be a big sigh of relief when the fight over the debt ceiling ends, at least I hope it ends with relief... But if an agreement is reached, we should be careful not to think that the overall level of uncertainty has been reduced... Republicans will simply move on to the next target, and then the target after that – why not so long as it works. Until they are done with their efforts to impose their ideological will through whatever means necessary, holding the nation hostage, whatever it takes, the uncertainty will persist.

The president might have been able to stop this behavior had he stood up to the threat the first time Republicans played this game. But he didn’t... This won’t stop unless the next election tells both Republicans and the Democrats who enable them, in no uncertain terms, that this behavior will not be tolerated.

A breakup of the euro “is not a big deal,” Taleb said yesterday at an event in Montreal hosted by the Alternative Investment Management Association. “When they break it up, there will be a lot of fun currencies. This is why I am not afraid of Europe, or investing in Europe. I’m afraid of the United States.”

Somehow I think this over-trivializes the situation in Europe. Just a little. Yes, a Euro breakup would create new currencies, and I imagine they could be thought of as "fun" depending on the printing, colors, artwork, etc. But overall, I don't think economic upheaval is the path to "fun."

And the fact that the GOP lying about the economy...and especially the budget...is so accepted and expected means that any Republican who wasn't jump-the-shark ridiculous on these issues wouldn't be allowed to stay in the party much longer. ...

House Speaker John Boehner (R-OH) ... easily qualifies as the weakest and least effective Speaker in my lifetime and has to be included on the list of the all-time worst in U.S. history, demonstrated yet again that he'll say and do anything to stay speaker even when what he's saying about the budget can easily be shown to be nonsense and when he knowingly and without giving it a second thought threatens the well-being of the U.S. economy.

I'd say this doesn't bode well for the outcome of this year's federal budget debate, but that's both obvious and an understatement. It actually points to the a period in U.S. history that is very likely to be labeled by historians as its economic dark ages.

I think that reporting on economic issues has improved, and that blogs have something to do with that. But when it comes to political reporting on economic (and other) issues, it's just as disappointing as ever. If there's no reputational or other costs associated with this behavior, why stop?

Tuesday, May 29, 2012

Via the NBER, evidence from Atif Mian and Amir Sufi that "Weak household balance sheets and the resulting aggregate demand shock are the main reasons for historically high unemployment in the U.S. economy." This is also evidence for the "balance sheet recession" characterization of the downturn that many of us have been advocating (and it points toward balance sheet repair type policies that go along with this perspective as a key component of attempts to help the economy recover):

Explaining the Rise of Unemployment, by Laurent Belsie, NBER Digest: Unemployment rose dramatically during the Great Recession because highly indebted consumers slashed their spending, according to Atif Mian and Amir Sufi writing in What Explains High Unemployment? The Aggregate Demand Channel (NBER Working Paper No. 17830). They find that shocks to household balance sheets account for 4 million of the 6.2 million jobs lost in the United States between March 2007 and March 2009.

The stage was set for a substantial shock to household balance sheets during the housing bubble. Housing prices rose sharply, but homeowners borrowed even more aggressively. Between 2001 and 2007, household debt doubled from $7 trillion to $14 trillion. Homeowners' debt-to-GDP ratio rose sharply, from 0.7 to 1.0, during the same period. When housing prices collapsed, households were stuck with much higher debt, forcing them to cut back spending, which has shaped the depth and length of the economic slump that followed.

Earlier research by these authors and others had already demonstrated the link between dramatically weaker household balance sheets and plummeting consumer spending. In high-debt U.S. counties, housing prices fell by nearly 30 percent from 2006 to 2010. Households in those counties slashed consumption of durable goods and even cut back grocery spending. In the 10 percent of U.S. counties with the lowest debt-to-income ratios, house prices didn't fall and the fall in consumption wasn't as dramatic. Consumption of durable goods fell 20 percentage points more in high-debt counties than in low-debt counties.

The high-debt counties got that way, at least in part, because of the housing bubble. During the boom, housing prices didn't rise uniformly: the biggest increases came in counties with terrain or regulatory environments that made it more difficult to build new homes. In turn, homeowners in those counties were more apt to boost their debt to unprecedented levels. This finding is important not only because it explains the variability of debt, but also because it points out the absence of a construction boom and bust in many of the most indebted counties.

Mian and Sufi find that employment losses in the non-tradable sector were greater in the U.S. counties with the most highly indebted households than in other counties. In the tradable sector, however, employment losses were more uniform across the United States. The relationship between high debt-to-income ratios and the sharp decline in non-tradable goods purchases allows the authors to estimate the impact of shocks to balance sheets, and therefore on aggregate demand and on nation-wide employment.

"Our main insight is that the relation between demand shocks and employment losses in industries catering to local demand can be used to estimate the effect of aggregate demand on aggregate unemployment," the authors conclude. "We believe that weak household balance sheets and the resulting aggregate demand shock are the main reasons for historically high unemployment in the U.S. economy."

Maybe I am too eager to believe it, and...: ..I expect to be smote down for saying it, but I think the two month old, mediocre, Case-Shiller number that came out today is consistent with the idea that the housing market will really come back big this year (I said so in the paper and on the radio today, so I might as well say it here).

Inventories in many hard hit markets are now low by historical standards. Time on market has fallen. HARP II can accelerate amortization (which is its most important feature). Prices are really cheap, both when the user cost they produce is compared with rent, and when compared with incomes (by World standards).

And the Yale research published today reveals that if Americans knew more basic science and were more proficient in technical reasoning it would still result in a gap between public and scientific consensus.

Indeed, as members of the public become more science literate and numerate, the study found, individuals belonging to opposing cultural groups become even more divided on the risks that climate change poses.

Funded by the National Science Foundation, the study was conducted by researchers associated with the Cultural Cognition Project at Yale Law School and involved a nationally representative sample of 1500 U.S. adults.

"The aim of the study was to test two hypotheses," said Dan Kahan, Elizabeth K. Dollard Professor of Law and Professor of Psychology at Yale Law School and a member of the study team. "The first attributes political controversy over climate change to the public's limited ability to comprehend science, and the second, to opposing sets of cultural values. The findings supported the second hypothesis and not the first," he said.

"Cultural cognition" is the term used to describe the process by which individuals' group values shape their perceptions of societal risks. It refers to the unconscious tendency of people to fit evidence of risk to positions that predominate in groups to which they belong.

The results of the study were consistent with previous studies that show that individuals with more egalitarian values disagree sharply with individuals who have more individualistic ones on the risks associated with nuclear power, gun possession, and the HPV vaccine for school girls.

society cannot exist without a …dominant… or… political class, and that the ruling class, while its elements are subject to frequent partial renewal, nevertheless constitutes the only factor of sufficiently durable efficacy in the history of human development. [T]he government, or, … the state, cannot be anything other than the organization of a minority. It is the aim of this minority to impose upon the rest of society a “legal order” which is the outcome of the exigencies of dominion and of the exploitation of the mass … Even when the discontent of the masses culminates in a successful attempt to deprive the bourgeoisie of power, this is … effected only in appearance; always and necessarily there springs from the masses a new organized minority which raises itself to the rank of a governing class…” (pp. 353-354).

...In our paper with Simon Johnson and Pablo Querubín “When Does Policy Reform Work?”, we analyzed exactly this process. We explained why policy reform, against the background of unchanged political institutions, may create a seesaw effect, whereby the reform of one distortionary, extractive policy leads to the rise of another. We then illustrated these ideas with central bank independence, adopted enthusiastically by many countries with the encouragement of international organizations since the 1990s. Central bank independence, except in places such as Zimbabwe where it doesn’t mean anything at all, does take away some of the tools that politicians under extractive institutions can use for clientelism or for personal enrichment. But if their incentives and constraints facing them and the political elites are unchanged, they will often find other tools to achieve the same objectives — and these other tools may sometimes be even more distortionary. So with more constraint on monetary policy after central bank independence, many countries with weak institutions start running bigger budget deficits. ...

Tax cuts seem to be the major extractive tool presently. Despite pledges from Obama and others to stand up to this and undo some of the extraction, it continues. When it comes to raising taxes on the wealthy or cutting benefits for the not so well off to balance the budget, its pretty clear whose interests are likely to prevail.

On average, according to Milliman, employers contributed 58 percent, or $12,144, to the total cost of $20,728, through contributions to their employees’ health insurance premiums. The family itself contributed another 25 percent, or $5,114, toward the premium via direct payroll deduction. In addition, it spent 17 percent, or $3,470, out of pocket for health care.

Although the family’s contribution of $8,584 is by no means trivial, it is less than half of the total average cost of a family’s health care cost. Most employees probably believe that “the company” – that is, its owners – absorbs the other 58 percent of the family’s total health spending.

Economists have long argued that this is an illusion – that over the longer haul the bulk and possibly all of the ostensibly employer-paid health insurance premiums gets indirectly shifted back into the employee’s paycheck through lower increases in take-home pay. ...

This point on backward cost-shifting was driven home recently in a paper in Health Affairs by David Auerbach and Arthur Kellerman. The authors present data showing that a decade of health care cost growth in employer-based health insurance “has wiped out real income gains for an average U.S. family” from 1999 through 2009. Health care has come to chew up American household budgets like Pacman. ...

Americans are fond of the idea that individuals and families should be self-reliant. But a question confronting the American public and their political representatives is how they imagine households with money income of, say, $30,000 to $50,000 will tolerate the ever-larger bites the health care Pacman seeks to take out of their budgets. ...

Plosser: Europe is clearly near recession. That impacts the U.S. in part through trade ... but Europe is not our largest trading partner at the end of the day. The thing that people really worry about is you have some financial implosion in Europe and markets freeze up and you have some serious financial disruptions.

There are several ways this could go. At one level the U.S. has been trying to insulate itself from that risk. The Fed and regulators have tried to stress to money market funds, for example, to reduce their exposure to European financial institutions. So on a pure exposure basis I would say U.S. financial institutions are taking the steps they need to ensure that ... financial distress in Europe it doesn’t necessarily lead to distress for them...

People have made the analogy that an implosion in Europe would be a Lehman Brothers-type event. It might be a Lehman Brothers-kind of event for Europe. And if the market is sort of indiscriminate in whom they withdraw funding to, you could have indiscriminate funding restrictions on U.S. institutions just because everybody’s scared.

There’s another scenario that is exactly the opposite. There might be–and you already see some of this–a flight to safety. So rather than the markets freezing access to short-term funding for U.S. institutions, you could have a flood of liquidity that gets withdrawn from European institutions ... and floods into the United States. That’s exactly the opposite problem.

On which scenario is more likely:

Plosser: I don’t have the answer to that. ... I don’t think a flood of liquidity is a huge problem. That would be manageable. The bigger problem is if it dries up for everybody. The Fed still has the tools it used during the crisis. ... So I think we have the tools at our disposal if they become necessary. ...

Thus, he thinks the Fed can handle whatever comes its way, and hence sees no need to alter his forecast:

On his economic forecasts:

Plosser: I’m still looking for 2.5% to 3% growth over the course of this year. I think the unemployment rate is going to continue to drift downward to 7.8% by the end of this year. I would think for 2013 we’ll see similar developments. As long as that’s continuing then I don’t see the case for ever increasing degree of accommodation.

Since he believes output will grow no matter what happens in Europe, inflation is the biggest risk:

On inflation:

Plosser: I think headline will drift down just because of oil and gasoline. It will be interesting to see what happens with the core. The inflation risk we have is longer term. The problem is that as the U.S. economy grows we have provided substantial amounts of accommodation. We have $1.5 trillion in excess reserves. Inflation is going to occur when those excess reserves start flowing into the economy. When that begins to happen we’ll have to restrain it somehow. The challenge for the Fed is will we act quickly enough or aggressively enough to prevent that from happening.

It may be a challenge politically when we have to start selling assets, particularly if we have to start selling (mortgage backed securities) to shrink the balance sheet and to prevent those reserves from becoming money.

My view is different. I'm more worried about output and employment being affected by events in Europe than he is, and less worried about long-run risks from inflation (both the chance that it will happen and the consequences if it does). So I see a far greater need for policymakers -- monetary and fiscal -- to take action now as insurance against potential problems down the road.

It is interesting, however, that he sees the political risk as the primary challenge for controlling inflation for a supposedly independent Fed, especially since several Fed presidents recently assured us that politics plays no role whatsoever in the Fed's decision making process (I also wonder why he didn't mention raising the amount paid on reserves as a way of keeping reserves in the banks).

Finally, I'm glad he said "I don’t see the case for ever increasing degree of accommodation," rather than saying he thought we needed to begin reducing accommodation. We may not get any further easing, but perhaps there's a chance we can keep what we have, at least for now.

However, for austerity to work "requires the fiscal austerity period to be sufficiently long, and the degree of initial pessimism in expectations to be relatively mild." That is, the policy must be left in place for a considerable period of time, and if there is expected deflation or an expected decline in output of sufficient magnitude, austerity is unlikely to be effective. The conditions for fiscal stimulus to work are not as stringent, so it is more likely to be effective, but even so "One disadvantage of fiscal stimulus and fiscal austerity policies is that both their magnitude and duration have to be tailored to the initial expectations, so they require swift and precise discretionary action."

Because of this, they suggest fiscal switching as the best policy. Under this policy the government keeps government spending (and taxes) constant so long as expected inflation exceeds a predetermined lower bound. But if expected inflation falls below the threshold, then government spending is increased enough to achieve an output level where actual inflation exceeds expected inflation. Thus, a rule that credibly promises strong fiscal action if expectations become pessimistic can avoid the bad equilibrium in these models. As they note:

Two further points should be noted about this form of fiscal policy. First, it is not necessary to decide in advance the magnitude and duration of the fiscal stimulus. Second, in contrast to the preceding section we now do not assume that agents know the future path of government spending.

In summary, our analysis suggests that one policy that might be used to combat stagnation and deation, in the face of pessimistic expectations, would consist of a fiscal switching rule combined with a Taylor-type rule for monetary policy. The fi scal switching rule applies when ination expectations falls below a critical value. The rule speci fies increased government spending to raise inflation above ination expectations in order to ensure that ination is gradually increased until expected ination exceeds the critical threshold. This part of the policy eliminates the unintended steady state and makes sure that the economy does not get stuck in a regime of deflation and stagnation. Furthermore, unlike the temporary fi scal policies discussed in the previous section, the switching rules do not require fine tuning and are triggered automatically. Remarkably, our simulations indicate that this combination of policies is successful regardless of whether the households are Ricardian or non-Ricardian.

Big Fiscal Phonies, by Paul Krugman, Commentary, NY Times: ...Until now the attack of the fiscal phonies has been mainly a national rather than a state issue, with Paul Ryan, the chairman of the House Budget Committee, as the prime example. As regular readers of this column know, Mr. Ryan has somehow acquired a reputation as a stern fiscal hawk despite offering budget proposals that, far from being focused on deficit reduction, are mainly about cutting taxes for the rich while slashing aid to the poor and unlucky. ...

The same can be said of Mitt Romney, who claims that he will balance the budget but whose actual proposals consist mainly of huge tax cuts (for corporations and the wealthy, of course) plus a promise not to cut defense spending.

Both Mr. Ryan and Mr. Romney, then, are fake deficit hawks. ... Still, Mr. Ryan and Mr. Romney are playing to a national audience. Are Republican governors, who have to deal with real budget constraints, different? Well, there have been many claims to that effect; Mr. Christie, in particular, has been widely held up, not least by himself, as an example of a politician willing to make tough choices.

But last week we got to see him facing an actual tough choice — and aside from the yelling-at-people thing, he proved himself just another standard fiscal phony.

Here’s the story:... Mr. Christie has been touting what he calls the “Jersey comeback.” Even before his latest outburst, it was hard to see what he was talking about... Yet Mr. Christie has been adamant that ... this makes room for, you guessed it, tax cuts that would disproportionately benefit the wealthy.

Last week reality hit:... the state faces a $1.3 billion shortfall. ... New Jersey, then, is still in dire fiscal shape. So is our tough-talking governor willing to reconsider his pet tax cut? Fuhgeddaboudit. ... So much for fiscal responsibility.

Will Mr. Christie’s budget temper tantrum end speculation that he might become Mr. Romney’s running mate? I have no idea. But it really doesn’t matter: whoever Mr. Romney picks, he or she will cheerfully go along with the budget-busting, reverse Robin Hood policies that you know are coming if the former governor wins.

For the modern American right doesn’t care about deficits, and never did. All that talk about debt was just an excuse for attacking Medicare, Medicaid, Social Security and food stamps. And as for Mr. Christie, well, he’s just another fiscal phony, distinguished only by his fondness for invective.

Sunday, May 27, 2012

More on the Politics of the Super-Rich, Monkey Cage: Andrew argues, based on “extrapolation from preferences of the top 5%, data on campaign contributions, and data on political attitudes of the top third of income,” that “there are lots more rich and powerful Republicans” than Democrats. While extrapolation from the top third, or even the top 5%, to the “super-rich” seems perilous, some new data on campaign contributions handsomely support his claim. ...

While these data seem compelling with regard to the partisan alignment of the super-rich, they do not speak to Andrew’s additional claim that “rich Democrats tend to be moderate on economic policy, whereas rich Republicans tend to be highly economically conservative.” ...

For what it’s worth, I suspect that Andrew is mostly right on this score as well—but also that there is a great deal of politically significant variation even within the domain of “economic policy.” For example, the finance industry super-rich in Bonica’s data look, on average, much like the rest of the super-rich. However, even those who contribute mostly or entirely to Democrats are probably not “moderate” on the issue of financial regulation—a fact that may be relevant to understanding why the regulatory response to the Wall Street meltdown was not more vigorous. ...

This graph from his post shows the ideological distribution of Democrats (blue), Republicans (red), and the Forbes 400 (black):

The strong demand for charlatans, by Chris Dillow: In the improbable event of ever being invited to give a commencement address, my advice to graduates wanting a lucrative career would be: become a charlatan. There has always been a strong demand for witchdoctors, seers, quacks, pundits, mediums, tipsters and forecasters. A nice new paper by Nattavudh Powdthavee and Yohanes Riyanto shows how quickly such demand arises.

They got students in Thailand and Singapore to bet upon a series of five tosses of a fair coin. They were given five numbered envelopes, each of which contained a prediction for the numbered toss. Before the relevant toss, they could pay to see the prediction. After the toss, they could freely see the prediction.

The predictions were organized in such a way that after the first toss half the subjects saw an incorrect prediction and half a correct one, after the second toss a quarter saw two correct predictions, and so on. The set-up is similar to Derren Brown's The System, which gave people randomly-generated tips on horses, with a few people receiving a series of correct tips.

And here's the thing. Subjects who saw just two correct predictions were 15 percentage points more likely to buy a prediction for the third toss than subjects who got a right and wrong prediction in the earlier rounds. Subjects who saw four successive correct tips were 28 percentage points more likely to buy the prediction for the fifth round.

This tells us that even intelligent and numerate people are quick to misperceive randomness and to pay for an expertise that doesn't exist; the subjects included students of sciences, engineering and accounting. ...

It's easy to believe that this happens in real life. For example, the people who are thought to have predicted the financial crisis of 2008 are invested with an expertise which they might not really have. ... This paper ... suggests ... people are too quick to perceive skill and thus to pay for something that doesn't exist. The demand for forecasters and tipsters substantially exceeds the real ability such pundits actually have.

Kahneman: ...Psychologists distinguish between a "System 1" and a "System 2," which control our actions. System 1 represents what we may call intuition. It tirelessly provides us with quick impressions, intentions and feelings. System 2, on the other hand, represents reason, self-control and intelligence. ...

System 2 is the one who believes that it's making the decisions. But in reality, most of the time, System 1 is acting on its own, without your being aware of it. It's System 1 that decides whether you like a person, which thoughts or associations come to mind, and what you feel about something. All of this happens automatically. You can't help it, and yet you often base your decisions on it. ...

System 1 can never be switched off. You can't stop it from doing its thing. System 2, on the other hand, is lazy and only becomes active when necessary. Slow, deliberate thinking is hard work. It consumes chemical resources in the brain, and people usually don't like that. …

Spiegel: By studying human intuition, or System 1, you seem to have learned to distrust this intuition…

Kahneman: I wouldn't put it that way. Our intuition works very well for the most part. But it's interesting to examine where it fails. ... In the stock market, for example, the predictions of experts are practically worthless. Anyone who wants to invest money is better off choosing index funds... Year after year, they perform better than 80 percent of the investment funds managed by highly paid specialists. Nevertheless, intuitively, we want to invest our money with somebody who appears to understand, even though the statistical evidence is plain that they are very unlikely to do so. ... The experts are even worse because they're expensive.

Spiegel: So it's all about selling snake oil?

Kahneman: It's more complicated because the person who sells snake oil knows that there is no magic, whereas many people on Wall Street seem to believe that they understand. That's the illusion of validity …

Spiegel: Do we generally put too much faith in experts?

Kahneman: I'm not claiming that the predictions of experts are fundamentally worthless. … Take doctors. They're often excellent when it comes to short-term predictions. But they're often quite poor in predicting how a patient will be doing in five or 10 years. And they don't know the difference. That's the key.

Spiegel: How can you tell whether a prediction is any good?

Kahneman: In the first place, be suspicious if a prediction is presented with great confidence. That says nothing about its accuracy. You should ask whether the environment is sufficiently regular and predictable, and whether the individual has had enough experience to learn this environment. ...

One implication of this is that we use rules of thumb rather than rational, deliberative thought (i.e. rational expectations) for many of our decisions.

Saturday, May 26, 2012

We may be entering a new world where international cooperative arrangements, in environmental areas as well as finance, are commonly recognized as impossible. If the core European nations cannot coordinate effectively, what can we expect in dealings with China, Russia and other countries that have less of a common background and understanding?

What is the answer?:

We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences.

Which reminds me of something Brad DeLong wrote awhile back:

We Need a Hegemon Who Won't Drive Us Crazy...: ...monetary policy is and always has been about supporting asset prices at a level that allows firms that ought to be expanding to obtain finance and expand profitably. And ever since 1825 the central bank has done this by, whenever it needs to, taking long-duration and risky assets into its own portfolio--and thus off of the stock that must be held by the private sector whose risk tolerance has collapsed. Given that there are going to be sudden shocks to risk and duration tolerance on the part of global investors, we need a global institution to provide support for asset prices in an emergency: a global lender of last resort.

That lender of last resort needs two things if it is to function. First, it needs to be able to "print money"--to have its own liabilities be and be perceived to be the safest assets in the world so that when it borrows it calms markets by giving them more of the high-quality short-duration low-risk paper for which they suddenly have such a great craving. Second, it needs to know what it is buying--to have sufficient regulatory oversight and control over global finance to be able to limit the growth of potentially toxic assets beforehand and then to understand what prices it should offer when it does decide that it is time to support the market.

As my old teacher Charlie Kindleberger taught me (or, rather, taught Barry Eichengreen, who in turn taught me), when the global financial system has had a hegemonic lender-of-last-resort with the power and the will to exercise this function, things have gone relatively well. And when the possible candidates for the role have lacked either the power or the will, things have gone relatively badly.

Back in the 1997-1998 crisis the U.S. Federal Reserve and Treasury acting alongside the IMF had the power and the will. Right now the U.S. Federal Reserve and the Treasury in cooperation with the IMF and the ECB have the power (but they may not have the will). In the future the world is likely to become a more complicated place without a single hegemonic and dominant public financial institution. To my mind, this creates grave dangers for the next quarter century. ...

Modeled Behavior has moved to Forbes, so I guess I should say that I have a blog there too. But I am not moving the blog, and no content will appear on the Forbes site that doesn't also appear here. My plan is to repost a small subset of the things that are posted at this blog each month, and nothing more (they are fully aware of my plans).

I have had many offers to move the blog over the years, and the first few were tempting (I think the Big Think was the first). However, though one should never say never, it's not moving. It took years of long, hard days to build this up to whatever meager status it might have attained (I try not to fool myself about how much influence it actually has), and I am not going to put that at risk by moving it somewhere else.

I could probably make a bit of money by moving, and I could also make quite a bit simply by pushing traffic to the Forbes blog. So if you want to show up there, interact in the comments thread, whatever, great. I'll make the most by far if you return a second time. But I am not going to do anything to encourage such behavior.

(On other outlets -- I don't make a dime more or less based upon traffic for my Fiscal Times columns, but they ask me not to reprint the columns on my blog and I honor that -- so not printing them here, except with a lag for the ones I think you'll be interested in, has nothing to do with making money for myself. I do get paid based upon traffic to the CBS stories I write, though not that much, and they have never protested when I reprint them here -- they have a huge traffic base to draw from already. So I try to dual post CBS stories whenever I think the story will be of interest. There are times when I don't post the whole story, just the title and a link, but that's usually when I write about something the editors suggest rather than something of my own choice, and I don't think there will be a lot of interest here.)

More generally, I could probably make a bit of spending money each month by placing ads on my blog. But I haven't done that, and I have no plans to do so. Why? Several reasons. For one, the state of Oregon pays me to educate the public (the education mission does not end with students, it's much more general than that, something too few professors understand). So I already get paid to do this. I suppose I should try to make enough to cover blog hosting fees, all the magazine and newspaper subscriptions I've added, and so on -- to at least break even -- but I haven't done that (and there are plenty of other perks, e.g. I'll be traveling to Kenya in a couple of weeks for a 10-day visit to report on economic conditions, we'll travel to quite a few areas of the country, more on this soon, and then on to this year's Nobel meetings in Lindau, Germany for a week all because of the blog -- and the costs are mostly covered by others so I have nothing to complain about).

But the fact that I am already paid to educate the public, and get credit from the Department and University for doing so, is not the biggest reason for the no-ads approach. Economists talk about incentives and how they affect behavior, and ads push me in directions I'd rather not go. As soon as I start trying to maximize monetary gains rather than maximizing education, it changes the posts -- the incentives are not well aligned. I become shriller, I find myself tempted by things that will attract lots of eyeballs even if they aren't as solid as they might be, and so on. It changes the posts in ways I don't want them to change, so it's best that I leave that temptation lying on the table (though I am far from perfect). Brad DeLong told me something important when I started -- don't write to your sitemeter. Check it once a week if you must (he suggested Saturday), but don't get trapped into writing to the ebb and flow of traffic or it will drive you nuts. Instead, write what you know best, that's what people want to read. It was great advice, at least for me. I follow inbound traffic closely -- where people are coming from -- but I haven't looked at daily traffic numbers for several years. I still have pretty good idea of what they are, but it's a bit vague and that is best for me.

Since I'm at this, one more thing. This blog has no color, it's blue and white mostly, there's a ton of wasted space in the header, etc., and every so often I think I should do a big redesign. However, I don't because I'm worried about changing from a somewhat colorless, dumpy looking blog would change its identity. I want it to look like what it is, a professor with a blog who is trying to help people understand economics and policy. It's not intended as a flashy, commercial, money-making device and giving it that look may rebrand it in a way that is harmful. So I haven't done much to add color and flare to the design (though I am still thinking I ought to try to make a few changes if I can ever find the time, but it's working as it is, pretty much, so why change?).

Finally, the blog at Forbes has been ready for a few days, but I haven't posted anything there yet (here's the address: http://blogs.forbes.com/markthoma/ ). I suppose I should let you know when I do post something, and if you want to click through and take a look, great. If not, you won't miss a thing. The reason I said yes is very simple to explain -- I saw it as a chance to extend the reach of the blog to more people. That's why I am only interested in reprinting content from here (and also why I allow the rss feed to be used freely by SeekingAlpha and RGE type aggregators). It allows me to potentially reach a few more people, and not necessarily be preaching to the already converted, which is important, without changing anything that I do here. The last thing I want to do is to make a move that might undermine Economist's View in any way whatsoever, and I hope this approach will meet that non-negotiable condition.

Robert Stavins has always seemed optimistic about the potential for action on climate change, but there seems to be a shift toward a more pessimistic posture. After making the case for a market-based regulatory approach (as opposed to, for example, mandates), which is worth reading too, he says:

In addition, U.S. political polarization – which began some four decades ago and accelerated during the economic downturn – has decimated what had long been the key political constituency in Congress for environmental (and energy) action: namely, the middle, including both moderate Republicans and moderate Democrats. Whereas congressional debates about environmental and energy policy have long featured regional politics, they are now largely partisan. In this political maelstrom, the failure of cap-and-trade climate policy in the Senate in 2010 was collateral damage in a much larger political war.

Better economic times may reduce the pace – if not the direction – of political polarization. And the ongoing challenge of large federal budgetary deficits may at some point increase the political feasibility of new sources of revenue. When and if this happens, consumption taxes – as opposed to traditional taxes on income and investment – could receive heightened attention; primary among these might be energy taxes, which, depending on their design, can function as significant climate policy instruments.

Many environmental advocates would respond that a mobilizing event will surely precipitate U.S. climate policy action. But the nature of the climate change problem itself helps explain much of the relative apathy among the U.S. public and suggests that any such mobilizing events may come “too late.”

Nearly all our major environmental laws have been passed in the wake of highly publicized environmental events or “disasters,” including the spontaneous combustion of the Cuyahoga River in Cleveland, Ohio, in 1969, and the discovery of toxic substances at Love Canal in Niagara Falls, New York, in the mid-1970s. But note that the day after the Cuyahoga River caught on fire, no article in The Cleveland Plain Dealer commented that the cause was uncertain, that rivers periodically catch on fire from natural causes. On the contrary, it was immediately apparent that the cause was waste dumped into the river by adjacent industries. A direct consequence of the observed “disaster” was, of course, the Clean Water Act of 1972.

But climate change is distinctly different. Unlike the environmental threats addressed successfully in past U.S. legislation, climate change is essentially unobservable to the general population. We observe the weather, not the climate. Until there is an obvious and sudden event – such as a loss of part of the Antarctic ice sheet leading to a dramatic sea-level rise – it is unlikely that public opinion in the United States will provide the bottom-up demand for action that inspired previous congressional action on the environment over the past forty years.

But then some of the optimism returns:

Despite this rather bleak assessment of the politics of climate change policy in the United States, it is really much too soon to speculate on what the future will hold for the use of market-based policy instruments, whether for climate change or other environmental problems.

On the one hand, it is conceivable that two decades (1988–2008) of high receptivity in U.S. politics to cap-and-trade and offset mechanisms will turn out to be no more than a relatively brief departure from a long-term trend of reliance on conventional means of regulation.

On the other hand, it is also possible that the recent tarnishing of cap-and-trade in national political dialogue will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments. Perhaps the ongoing interest in these policy mechanisms in California (Assembly Bill 32), the Northeast (Regional Greenhouse Gas Initiative), Europe, and other countries will eventually provide a bridge to a changed political climate in Washington.

To me, one of the most frustrating elements of this is so-called market defenders in the GOP standing in the way of policies that would internalize externalities and improve how these markets function. Despite what Republican "market defenders" say, in the end distribution -- who gets what -- is more important than efficiency for this group. They talk about efficiency, growth, blah, blah, blah, but in the end protecting the ability of supporters to earn high profits in finance, energy -- wherever -- carries the day over regulations that could make these markets work better.

Friday, May 25, 2012

Ruin the economy, then get indignant and whiny if anyone points that out:

Egos and Immorality, by Paul Krugman, Commentary, NY Times: In the wake of a devastating financial crisis, President Obama has enacted some modest and obviously needed regulation; he has proposed closing a few outrageous tax loopholes; and he has suggested that Mitt Romney’s history of buying and selling companies, often firing workers and gutting their pensions along the way, doesn’t make him the right man to run America’s economy.

Wall Street has responded — predictably, I suppose — by whining and throwing temper tantrums. ... But ... before I get to that, let me take a moment to debunk a fairy tale that we’ve been hearing a lot from Wall Street and its reliable defenders — a tale in which the incredible damage runaway finance inflicted on the U.S. economy gets flushed down the memory hole, and financiers instead become the heroes who saved America.

Once upon a time, this fairy tale tells us, America was a land of lazy managers and slacker workers. Productivity languished, and American industry was fading away in the face of foreign competition.

Then square-jawed, tough-minded buyout kings like Mitt Romney and the fictional Gordon Gekko came to the rescue, imposing financial and work discipline. Sure, some people didn’t like it, and, sure, they made a lot of money for themselves along the way. But the result was a great economic revival, whose benefits trickled down to everyone.

You can see why Wall Street likes this story. But none of it — except the bit about the Gekkos and the Romneys making lots of money — is true..., and there are real questions about why, exactly, the wheeler-dealers have made so much money while generating such dubious results. ... And it has been especially sad to see some Democratic politicians with ties to Wall Street, like Newark’s mayor, Cory Booker, dutifully rise to the defense of their friends’ surprisingly fragile egos.

As I said at the beginning, in a way Wall Street’s self-centered, self-absorbed behavior has been kind of funny. But while this behavior may be funny, it is also deeply immoral.

Think about where we are right now, in the fifth year of a slump brought on by irresponsible bankers. The bankers themselves have been bailed out, but the rest of the nation continues to suffer terribly, with long-term unemployment still at levels not seen since the Great Depression...

And in the midst of this national nightmare, all too many members of the economic elite seem mainly concerned with the way the president apparently hurt their feelings. That isn’t funny. It’s shameful.

As measured by Treasury bonds, inflation expectations are falling amid heightened concerns that the discord in Europe will threaten U.S. growth. Some observers say that the lowered outlook for inflation gives the Federal Reserve more leeway to stimulate the economy, possibly through another round of quantitative easing. In "QE," the Fed pumps money into the financial system through asset purchases.

Financial market participants are anticipating Fed action. Are monetary policymakers on the same page? St. Louis Federal Reserve President James Bullard yesterday:

Bullard said he believes the European Central Bank is committed to backing the continent's brittle banking system, and therefore the risks to the U.S. economy are smaller than some analysts perceive.

Indeed, Bullard added he expects the U.S. economy to perform better than many forecasters anticipate and that the Fed will therefore need to raise interest rates in late 2013, not late 2014 as its policy committee is currently indicating.

“I see these changes as a signal that our country’s current labor-market performance is much closer to ‘maximum employment,’ given the tools available to the [Fed], than the post-World War II U.S. data alone would suggest,” Kocherlakota said. “As I’ve argued in the past, appropriate policy should be responsive to such signals.”...

...Earlier in May, Kocherlakota said the Fed should start looking at tightening monetary policy in the next six to nine months. He said he saw inflation at around 2% this year and 2.3% in 2013, numbers that signal the need to start exiting the central bank’s current ultra-easy policy.

Arguably, neither Bullard not Kocherlakota are critical voices in the FOMC. More interesting are today's comments from New York Federal Reserve President Wiliam Dudley. From the Wall Street Journal:

Expectations for U.S. economic growth, while “pretty disappointing” at around 2.4%, is sufficient to keep the central bank from easing monetary policy, Federal Reserve Bank of New York President William Dudley said.

“My view is that, if we continue to see improvement in the economy, in terms of using up the slack in available resources, then I think it’s hard to argue that we absolutely must do something more in terms of the monetary policy front,” Dudley said in an interview with CNBC, aired Thursday.

Dudley is considered part of the inner circle; if he doesn't think the Fed needs to do something more, the baseline scenario should be that QE3 is not on the table.

At least for the moment. Simply put, I think market participants are getting ahead of the Fed. My suspicion is that the Fed will need to see a weaker data flow in the months ahead to justify getting back into the game. And I don't think the TIPS-derived inflation expectations are lower enough to trigger action either. I think we need to go down at least another 25bp if not 50bp until the Fed pulls the trigger:

That said, of course the risks to the outlook could shift by the June meeting. The trend in new orders for nondefense, nonair durable goods suggests that some of the global weakness is catching up with the US:

That said, no clear sign that industrial demand has rolled over. Overall, it seems unlikely that the data flow as a whole will turn fast enough to prompt the Fed into easing next month. Only the next employment report stands out as a potential deal breaker. In general, though, I would think you need at a minimum the Q2 GDP report to justify additional easing - which pushes us out to the July/August meeting at least.

So if we take the US data off the table, then we are looking for financial disruption, which is obviously a possibility given the current unpleasantness in Europe. Indeed, we should not be surprised if the Fed needs to further improve dollar liquidity abroad (an action that is sure to be taken as a sign that QE3 is imminent; expect Fed speakers to deny a policy shift is afoot). And note that the next FOMC meeting is just 2 days after the June 17 Greek vote - and that could be the vote heard round the financial world that prompts the Fed to act.

Bottom Line: The data flow is soft, but Dudley indicates it is not soft enough to ease. And while some are pointing to falling TIPS-derived inflation as given the Fed room to move, they have traditionally delayed until conditions are more dire (they are not exactly prone to overshooting in the first place). The Fed doesn't think they will ease further; they think their next move will be to tighten. Which means that financial conditions will need to deteriorate dramatically to prompt action in June. So if you are looking for the Fed to ease in just four weeks, you are looking for financial markets to turn very, very ugly. Lehman ugly. And I wish that I could say that it won't happen, but European policymakers are hell-bent to push their economies to the wall while worshipping at the alter of moral hazard.

Thursday, May 24, 2012

“We’re now in a very sentiment-driven, rumor-driven, nonsense-driven market that’s prepared to grasp onto anything,” Dow Jones’s Katie Martin said this morning on the Markets Hub.

One of the only things holding the euro up, she said, is the so-called “announcement risk,” the fear that the eurocrats will actually pull together some kind of solution. But it’s just a hope, she said

U.S. stocks rose, sending the Standard & Poor’s 500 Index higher for a fourth day, after Italian Prime Minister Mario Monti said a majority of leaders at a European Union summit backed joint European bonds.

But summit leaders agreed such measures were months – and, in the case of eurozone bonds, years – away, and some officials have in recent days begun to express concern that the EU has not properly prepared itself for the whirlwind that could strike if a new Greek government defaults on its bailout loans and is forced out of the euro.

Most of Europe might support Eurobonds, but it isn't going to happen in the near-term. Interestingly, Monti also laid down his own gauntlet to Germany. From Bloomberg:

Italian Prime Minister Mario Monti said Germany has an interest in ensuring that no country leaves the euro.

Monti said that, in a hypothetical case, Germany would be harmed should Italy “one day leave the euro.” A weak “new lira” would put German exports at a disadvantage, though an exit from the currency region would also harm Italy, Monti said in an interview today on Italian television La7.

While “anything can happen in Greece,” the nation is likely to remain in the 17-nation currency, Monti said.

A clear escalation of the doctrine of mutually assured financial destruction - now Italy has its hand on the button. The more hands on the button, the greater the chance that someone pushes it. Meanwhile, while European politicians fiddle, Europe burns. From Reuters:

The euro zone's private sector has sunk further into the doldrums this month as new orders shrivel, forcing firms to run down backlogs and slash workforces, key business surveys showed on Thursday.

And worryingly for policymakers, a downturn that started in smaller periphery members is taking root in the core countries of Germany and France, whose tepid growth had been keeping the troubled bloc afloat.

We are living at a critical juncture in the history of the Union. The sovereign debt crisis has exposed serious weaknesses in the institutional framework; in this context, the difficulties in finding common solutions are having a negative impact on market valuations. The extraordinary measures taken by the ECB have gained us time; they have preserved the functioning of monetary policy.

But we have now reached a point where European integration, in order to survive, needs a bold leap of political imagination. It is in this sense that I have referred to the need for a “growth compact” alongside the well-known “fiscal compact”.

That sounds to me like he is saying their is not much more that the ECB can or will do. Policymakers need to get their act together. I'll see your moral hazard, and double it. See who blinks first.

Moreover, it is increasingly clear it's not just Europe anymore. Ed Harrison reiterates that this is turning into a global slowdown:

Me, I am more concerned about the global growth slowdown in emerging markets than the crisis in Europe. This is a big, big story but no one is talking about it because Europe is sucking up all of the air. It’s not only Europe here. The reality is we are seeing a global economic backdrop with nearly every major developed and developing country slowing – all with less policy space across the board. That is not bullish.

To their credit – even Republican leaning economists were critical of any claim we could get the unemployment rate down to 4% by the end of 2016 but why retreat to a goal of 6% unemployment when even the CBO is forecasting we’d get close to 5.5% by then? CBO seems to be saying: (a) that the GDP gap won’t fully close until the end of the decade; and (b) that the unemployment rate will be north of 5% when it does close. So is Mr. Romney promising to do worse than what is expected under current policy? Given the state of the economy and our dismal fiscal policy which is akin to doing nothing, I could almost vote for a Republican who decided to both promise a more vigorous return to full employment and put forth a credible plan to get there. CNN outlines what Mr. Romney claims is his plan:

"Well, there are a number of things," Romney said on Fox News. "You start off by saying, let's stop something that's hurting small business from creating jobs and that's 'Obamacare.' Get rid of it. No. 2, have an energy strategy that takes advantage of our natural gas and oil and coal, as well as our renewables. Those low cost energy fuels will ultimately mean jobs come back here, even manufacturing jobs that left here. And finally, get a handle on the deficit so that people understand if they invest in America, their dollars will be worth something in the future."

#1 is a return to a failed health care system and #2 is continued reliance on fossil fuels. Both are bad policies but neither has much to do with the current macroeconomic mess. So had he stopped there, I could understand his not so ambitious goal of reaching a 6% unemployment rate. But then he had to mention #3, which is austerity. Which is working so well in the UK and Europe – not! We have heard from the CBO that allowing the fiscal cliff will lead to another recession. I guess the Republicans are promising some other variation on austerity, which if implemented would mean a continued high GDP gap and high unemployment. Is Mr. Romney running for the office of President or Head Cheerleader?

The Fed could therefore proclaim to the world that will maintain aggregate demand growth (in the form of, say, nominal income growth) at all costs, and that it would by no means allow the fiscal cliff to knock the economy off its preferred path. It could explain in great detail what specific steps it would be willing to take to achieve this goal, so as to boost its credibility. And if demand expectations as reflected in equity or bond prices showed signs of weakening ahead of the cliff, the Fed could preemptively swing into the action to establish the credibility of its purpose.

The Fed will almost certainly not do this.

Why? Because the Fed is thinking about moral hazard, specifically, that if it promises to protect the economy against reckless fiscal policy Congress will have no incentive to avoid reckless fiscal policy...

I understand where Avent is going with this. The Fed should be concerned that Congress will never get its act together if the Fed is always there to bail them out. But reading the comments by Minneapolis Federal Reserve President Narayana Kocherlakota today makes me think his concerns are at least for the moment misplaced. From the Chicago Tribune:

The U.S. Federal Reserve, which has kept short-term rates near zero since December 2008, may need to ease monetary policy further if U.S. unemployment rises or inflation falls, a top Fed official said on Wednesday.

Those are possible outcomes if U.S. lawmakers allow a raft of tax breaks to expire on schedule at the end of the year, pushing the nation over a "fiscal cliff" in 2013, Minneapolis Fed President Narayana Kocherlakota said in answer to an audience question after a talk at the Black Hills Knowledge Network.

But, he added, "I don't see that that is a policy choice that the Congress and President wind up making," he said.

That sounds to me like a pretty explicit promise to step up if Congress falls down on the job. Likewise, St. Louis Federal Reserve President James Bullard, via Reuters:

"If there was a sharp slowdown in the U.S. I do think we'd have further scope to take action, we'd be taking on more risk, but we could do it if the situation called for it," he said.

I take this to implicitly include a fiscal cliff slowdown. So it seems to me that at least some monetary policymakers are already promising, explicitly or implicitly, to offset the fiscal cliff.

My guess is that in a low-inflation environment, monetary policymakers would have little reason to engage in moral hazard games, in that any hesitation on their parts would not be credible. It seems pretty likely they would step on the monetary gas, even if doing so allowed Congress another year of reckless behavior. Not doing so would be a clear violation of the dual-mandate. As such, are they really able to play coy?

Whether they accurately gauge the impact of the fiscal cliff and engage in the appropriate degree of easing, however, is another matter entirely.

Total Failure, by Tim Duy: With the crisis once again nipping at their heels, European policymakers accomplished exactly what was expected of them. Absolutely nothing. From the FT:

European leaders put off any decisions on shoring up the region’s banks at a late-night summit on Wednesday despite rising concerns that instability in Greece was undermining confidence in the eurozone’s financial sector.

Instead, the heads of the EU’s main institutions were given the task of drawing up proposals for closer fiscal co-ordination in time for another summit next month, including plans that could include a path towards a Europe-wide deposit guarantee scheme and, in the longer term, commonly-backed eurozone bonds.

The trouble is that Europe doesn't have a month to wait for another summit. I am not confident they even have a week. But not to fear - the ECB is expected to step into the breech once again. At least that is the hope. But notice the irony. Germany doesn't want Eurobonds because of the moral hazard risk. They don't want to get stuck paying for Southern Europe's profligacy. At the same time, the ECB does want to act as lender of last resort for fear that will only encourage policymakers to put off hard decisions on fiscal union. Moral hazard to the right, moral hard to the left. The only path left is gridlock - and failure.

European officials are stepping up contingency planning for a possible Greek exit from the euro zone, even as Europe's leaders struggled to overcome differences on how to resolve the currency bloc's crisis at a summit meeting here.

And, for good measure, St. Louis Federal Reserve President James Bullard let's us know that he sleeps easy at night. Via Reuters:

"I'm one that thinks that Greece could exit, and it could be handled in an appropriate way without causing too much damage, either in Europe or in the U.S.," St. Louis Federal Reserve Bank President James Bullard told Reuters.

Wednesday, May 23, 2012

Cutting Off Your Nose...: ...to spite your face. This should be the new, official slogan of German policymakers. It is pretty clear that financial conditions in Europe are unravelling, now putting the Euro into free-fall. European policymakers simply became far too complacent over the winter, thinking that the ECB's two LTROs had fixed the problem. And, in a sense they did - for the moment. But as it became increasingly evident that the ECB was back out of the game, everything went sour. The economic realities came back into play. Moreover, there has been precious little action taken to resolve those problems - essentially, the lack of an federal fiscal institutional structure - that would make a common currency workable.

Moreover, Germany continues to block movement in that direction. From the FT:

Germany refused to share the debt burden of stressed eurozone peers on Tuesday, ignoring two of the most influential international economic bodies which offered support for proposals championed by Paris, Rome and Brussels ahead of a summit.

Angela Merkel, Germany’s chancellor, has argued that any co-mingling of eurozone debt would remove incentives for southern economies to adopt structural reforms. The calls from the International Monetary Fund and the Organisation for Economic Co-operation and Development came on the eve of Wednesday’s EU summit.

Merkel sees a large stick as the only way to end the crisis. She is unwilling to recognize that she needs to match that stick with a large carrot. At the end of the day, rather than concede on the necessity of internal fiscal transfers to make this work, she would rather doom the entire project to failure.

And speaking of the path to failure, notice another warning sign. Germany is now selling zero coupon bonds. Again from the FT:

Germany sold €4.5bn of two-year government bonds at a record low yield of 0.07 per cent, underscoring the strong demand for safer assets amid fears that Greece could be forced out of the eurozone.

Germany is rushing headlong on the Japanese (and arguably) US path, dragging the rest of Europe along for the ride. Of course, German policymakers see it exactly the other way, and worry about the moral hazard implications of changing course. But Europe is beyond moral hazard, which at this point is just something to talk about over a few pints at the pub. Germany needs put moral hazard concerns in the back seat and find a cooperative path, and needs to find it soon.

This reinforces points I (and others) have made about why people oppose taxes:

Why are some people morally against tax?, EurekAlert: ...Americans are famously hostile to taxes even though they are not heavily taxed in comparison to Canadians and the British. ...Dr Jeff Kidder and Dr Isaac Martin, from Northern Illinois University and the University of California-San Diego, explore how middle class feelings of exploitation lie behind this hostility.

"Everyday tax talk among the middle class is not simply part of a wider ideological view about economics or free markets," said Kidder. "Tax talk is morally charged and resonates with how Americans see themselves and their place in society."

The researchers conducted 24 semi-structured, open-ended interviews with taxpayers in the Southern states who owned or managed small businesses to discover how they talk about taxes in everyday life. Entrepreneurs are a demographic group which is typically strongly anti-tax, while the Southern States provide many supporters for the radical Tea Party.

Respondents saw themselves as morally deserving and hard-working people, sandwiched between an economically more powerful group that manipulates the rules for its own benefit and a subordinate group that benefits from government spending but escapes taxation.

"We found that people associate income tax with a violation of the moral principle that hard work should be rewarded," said Kidder. "Our research shows that when Americans lash out at 'takeovers,' 'massive taxes' and 'bailouts,' they are looking at these issues from the perspective of a hard-working middle class besieged on all sides. Tax talk is about dollars, but it is also about a moral sense of what is right."

It is typically believed that those who are anti-tax will also be hostile to government aid for the poor and minorities. However, rich recipients of bailouts were also disparaged as people who did not deserve money because they did not work for it.

"A lot of the tax talk you will hear from politicians this election season makes no sense as arithmetic," Martin said. "But it makes sense as an appeal to the moral sensibilities of small business."

"Our research shows that tax talk is not actually about individual self-interest, but about our respondents' sense of the proper relations among groups," concluded Kidder.

...People believe they paid for programs such as Social Security and Medicare. They put in contributions each month, the government saves that money somewhere, somehow, and when they use these programs they aren't consuming from "government," they are consuming their own contributions. ...

So it's true that people want the budget cut, but only the parts where people are forced to pay for "underserving" recipients of these government services. The feeling is that they get up every day and do what's needed to support themselves and their families. They go each day to jobs they hate, hate, hate, hate with a passion because that's how life is, and they don't appreciate seeing their hard-earned money taken away and given to people who don't even try, people who could work if they wanted to, but rely on the system instead.

Now, I happen to think that is a very wrong view of the circumstances of the typical aid recipient, but true or not I do think it is the source of the opposition to many social programs. People don't object to Social Security and Medicare because they believe they paid for these programs in full, or close to it. Same for disability, food stamps, and other programs. They paid into these programs for years, just like medical insurance, and now it's their turn to consume some of the funds they put in... It's the people who consume without contributing that raise their ire and cause objections to these programs. It's the "handouts" that are the problem. ...

And as noted above, the same applies to handouts to the wealthy. (Which reminds me of my mom criticizing my uncle as I was growing up -- a very well off and very Republican farmer -- for complaining about welfare recipients while taking crop subsidy payments himself. She used to tell me he was on welfare too, except he didn't need it. I'll just add that financial executives in too big to fail banks didn't need it either.)

Tuesday, May 22, 2012

... By focusing on the marketability of particular things, Sandel misses the larger effect of an economy regulated by markets on the evolution of social morality. Movements for religious and lifestyle tolerance, gender equality, and democracy have ﬂourished and triumphed in societies governed by market exchange, and nowhere else.

My colleagues and I found dramatic evidence of this positive relationship between markets and morality in our study of fairness in simple societies—hunter-gatherers, horticulturalists, nomadic herders, and small-scale sedentary farmers—in Africa, Latin America, and Asia. Twelve professional anthropologists and economists visited these societies and played standard ultimatum, public goods, and trust games with the locals. As in advanced industrial societies, members of all of these societies exhibited a considerable degree of moral motivation and a willingness to sacriﬁce monetary gain to achieve fairness and reciprocity, even in anonymous one-shot situations. More interesting for our purposes, we measured the degree of market exposure and cooperation in production for each society, and we found that the ones that regularly engage in market exchange with larger surrounding groups have more pronounced fairness motivations. The notion that the market economy makes people greedy, selﬁsh, and amoral is simply fallacious.

A few themes popped since last Friday that are worth considering. First is that some calmer voices have come to the forefront, arguing that a Greek exit is not really all that likely. See Brad Plummer at Ezra Klein's blog or Kate MacKenzie at FT Alphaville. The general point: Breaking up is hard to do. No argument here - a Greek exit would be ugly for Greece, and the rest of Europe as well. And, by all accounts, the Greek people don't want that outcome. The problem, however, is that the alternative, unending austerity to induce a substantial internal devaluation, is not really a solution either.

Indeed, it seems to me that on the current path, the cost of austerity will soon outweigh the cost of exit. And we are running out of time to change that trajectory. As I noted in my last post, it looks like the Greece fiscal situation is quickly deteriorating. And it looks like a collapsing tourism industry will only worsen the economy, thereby putting additional pressure on deficit to GDP targets. From FT Alphaville:

Greece received a boost last year as the unrest in the Middle East made countries such as Egypt unattractive destinations. But it looks like German tourists won’t be propping up the Greek economy so much this summer...

...When you think of the tax revenue that might be lost from this drop in activity, it’s possibly another sign that the bailout programme may be so far off course since the elections that it could have to be renegotiated anyway.

The last bailout is quickly being overtaken taken overtaken by events. What will be the demands of any new bailout? If history is any guide, more austerity - and with it a higher probability of exit.

This seems to be exactly the story that Syriza party leader Alexis Tsipras is trying to sell in Germany. To be sure, this is politically motivated, as he seeks to convince Greeks that voting for his party does not ensure an exit. Indeed, he is pushing the opposite story - that only by tearing up the bailout agreement can Greece stay in the Euro. From Bloomberg:

“Until when should German taxpayers pay into a bottomless pit?” Tsipras said to reporters in Berlin today after he held talks with leaders of Germany’s anti-capitalist Left Party. “It apparently flows to the Greek economy, but in reality only the banks and bankers are being financed.”...

...For Greeks, voting for Syriza “doesn’t mean that we’ll be kicked out of the euro,” he said. “It will mean a great opportunity for us to save the euro.”

A victory for Syriza would mean stability for Greece, whereas insisting on a continuation of the “catastrophic” austerity measures means a return to the drachma, Tsipras said.

I think he is right - except that to the Germans, tearing up the bailout is the same thing as exiting the Euro. Both sides have their hands on the buttons that ensure mutually assured financial destruction, and each austerity package forces Greece closer to pushing that button.

Another theme is one I find particularly intriguing - the idea that Greece will establish an internal currency that trades side-by-side with the Euro. FT Alphaville explains a version of this plan by Deutsche Bank’s Thomas Mayer. The basic idea is that the government will need to turn to issuing some kind of IUO's in the weeks ahead due to its deteriorating fiscal situation. The new currency would trade internally and need to be exchanged for Euros to pay for imports. The exchange rate would not be one to one, of course, and internal prices would be devalued against the Euro. To prevent the banking system from collapsing, it would need to be pulled into European supervision that guarantees Euro denominated accounts - thereby alleviating the fear of depositors that their Euro accounts would be replaced with a New Drachma, thus preventing a massive bank run. This is only a half exit, and the goal would be to stabilize the budget to the point where the government could cease printing the New Drachmas and eventually return to the Euro.

I am not confident this would work - and particularly not confident that the Greek government could wisely use its new-found power of the printing press. But it is a possible third way out, and this is a situation that desperately needs a third way.

But next month's elections in Greece could dramatically change the euro zone's political calculus, analysts say. A victory by parties opposed to the bailout negotiated with the euro zone and the International Monetary Fund would sharply raise the risk of Greece leaving the currency area, and possibly prompt policy makers to adopt more far-reaching measures to contain the turmoil arising from such a threat.

These bolder policies include the creation of "euro bonds," or debt jointly guaranteed by the euro zone that would allow weaker countries such as Spain to borrow at interest rates partly subsidized by Germany. Berlin remains staunchly opposed, though new French President François Hollande is expected to raise the topic during informal discussions at the summit.

Edward Harrison argues that Germany is not entirely opposed to the idea and see a path - an austerity-laden path - to Eurobonds. (Other views on the role of Eurobonds can be found at the NYT's Room for Debate). The challenge, however, is that Europe doesn't have time to wait. Nor does it have time to wait for the other institutional plumbing, such a mechanism for Eurozone bank recapitalization under a full banking union.

Lacking a path to a real fiscal and economic union, the outcome of tomorrow's EU meeting is likely to disappoint. Back to the Wall Street Journal:

Without agreement on these major steps, the leaders will in the meantime back three relatively minor policy initiatives. The first is a proposal to increase the capital of the European Investment Bank, the bloc's long-term lending arm, by €10 billion. The second proposal would ease requirements for troubled governments to use funds due to them from the EU budget.

The third is a plan to borrow money against the EU budget that would be dedicated to infrastructure-investment projects. The plan would create a pilot project using €230 million in EU budget money that could leverage funds of up to €4.6 billion. After two years, the program will be reviewed and possibly increased.

Analysts say none of these ideas is enough to have a significant, near-term macroeconomic effect in the bloc's troubled economies.

"These ideas don't materially improve trend growth prospects in the euro zone," said Mujtaba Rahman, an analyst at the Eurasia Group, a political risk consulting firm. "It's a lot of rhetoric and not a lot substance."

Enough to look like policymakers are doing something, but a far cry from the steps needed to bring the crisis under control. In other words, more of the same.

No matter what Republicans say, always remember the ultimate goal is more tax cuts for their supporters:

Don’t let Congress fast-track another tax cut, Andrew Fieldhouse: House Speaker John Boehner’s (R-Ohio) high-profile speech at last week’s 2012 Fiscal Summit garnered much attention for its pledge to again hijack the debt ceiling; less noticed was his announcement that the House of Representatives will establish a fast-track process for expediting “tax reform.” Comprehensive tax reform could add much needed revenue and balance to a long-term deficit..., but that’s not what Boehner is talking about:

“If we do this right, we will never again have to deal with the uncertainty of expiring tax rates. We’ll have replaced the broken status quo with a tax code that maintains progressivity, taxes income once, and creates a fairer, simpler code. And if we do that right, we will see increased revenue from more economic growth.” (Full text here.)

Anything resembling the tax plan recommended by Ways and Means Committee Chairman Dave Camp (R-Mich.) and included in Budget Committee Chairman Paul Ryan’s (R-Wis.) fiscal 2013 budget resolution—Boehner’s chief fiscal policy deputies—is going to have a devilishly hard time meeting this laundry list of talking points. That’s because conservatives falsely equate a “simpler” tax code with cutting and consolidating tax brackets, which would confer big tax cuts to upper-income households in the top tax brackets. This is the bedrock of the Camp-Ryan tax plan: “Consolidate the current six individual income tax brackets into just two brackets of 10 and 25 percent.” Short of unspecified offsets, this would sap progressivity from the tax code and deprive the Treasury of $2.5 trillion over a decade—accounting for more than half of the $4$4.5 trillion of unfunded tax cuts proposed in the Ryan budget. Combined with the other major tenants—repealing the alternative minimum tax (AMT), cutting the corporate tax rate to 25 percent, exempting foreign profits from taxation, and repealing health care reform—the tax code would be markedly flattened at the top of the income distribution...:

The red bars show what regressive upper-income tax cuts and lower-income tax increases look like, not what tax reform looks like. The missing element is how the tax cuts would be financed—i.e., which unspecified tax expenditures would be eliminated in “broadening the tax base.” House Republicans object to eliminating or even scaling back the preferential tax rates on capital gains and dividends—the tax expenditures most disproportionately benefiting upper-income households—which would be the only feasible way to maintain progressivity at the top of the income distribution...

Lastly, Boehner’s implied objectives of revenue and distributional neutrality—which guided the Tax Reform Act of 1986—are now wholly inappropriate benchmarks, as they would lock-in the past decade’s unaffordable and regressive Bush-era tax cuts and exacerbate Gilded-Age levels of income inequality. ...

If Congress really is heading toward comprehensive tax reform in the next few years, policymakers need to be kept honest about what amounts to reform versus a tax cut. The United States simply can’t afford to let Congress fast-track another tax cut disguised as “tax reform.” And House Republicans are currently $4.5 trillion shy of proposing even revenue-neutral tax reform.

Beyond the unspecified cuts, etc., it's hard to believe they are still trying to get away with the claim that tax cuts will increase revenue and actually help with the long-term deficit -- that won't happen, it will make the deficit worse just as it did in the past. But I guess if the press lets you get away with bogus claims, unspecified cuts and the like, why not say whatever?

The Irresponsibility of Speaker John Boehner, by Stan Collender: ...Speaker John Boehner’s (R-Ohio) choreographed events last week in which he repeatedly said he would prevent the debt ceiling increase that will be needed at the end of 2012 or the start of 2013 from happening unless he got what he wanted — was so exceptionally irresponsible.

I’m using the word “irresponsible” very deliberately.

Boehner is more than just a Member of Congress. As Speaker, he is next in line to the presidency after the vice president and the most powerful person in the House. That magnifies the importance of everything he says. ... The Constitution gives Congress specific fiscal policy responsibilities — that makes what this or any Speaker says something that makes headlines and is taken very seriously.

Coming on the heels of last year’s downgrade, the very public way Boehner repeatedly issued his debt ceiling threat made it the equivalent of alerting S&P and the other rating agencies that little had changed since last summer. It also was an invitation to again downgrade U.S. debt. ... There’s no word for that other than irresponsible.

Boehner’s threat also was irresponsible because the immediate spending cuts he said were the only way he would allow a debt ceiling increase to be considered is the wrong fiscal policy for the current economic situation. At a time when businesses and consumers are still not spending and most state and local governments are continuing to cut back, the federal government is the only major gross domestic product component enhancing growth and creating jobs. Given the current slow recovery, the large spending cuts Boehner is demanding could push the economy back into recession. ...

One of the points I was trying to make here is that if you look at the constituency Boehner is trying to satisfy, a constituency that has changed over time as wealth and power have become more concentrated, his tactics become more transparent and understandable. That doesn't excuse the fact that Republicans have turned their backs on the unemployed, nor does it excuse holding the economy hostage in order to make ideological gains, but it does help to explain the behavior.

First, you’re going to have a hell of a hard time finding a job. ... But even when you get a job, it’s likely to pay peanuts. ... Presumably ... when we come out of the gravitational pull of the recession your wages will improve. But there’s a longer-term trend that should concern you.

The decline in the earnings of college grads really began more than a decade ago. ... Don’t get me wrong. A four-year college degree is still valuable. Over your lifetimes, you’ll earn about 70 percent more than people who don’t have the pieces of parchment you’re picking up today.

But this parchment isn’t as valuable as it once was. So much of what was once considered “knowledge work” ... can now be done more cheaply by software. Or by workers with college degrees in India or East Asia, linked up by Internet.

For many of you, your immediate problem is that pile of debt on your shoulders. In a few moments, when you march out of here, those of you who have taken out college loans will owe more than $25,000 on average. Last year, ten percent of college grads with loans owed more than $54,000. ... Loans to parents for the college educations of their children have soared 75 percent since the academic year 2005-2006.

Outstanding student debt now totals over $1 trillion. That’s more than the nation’s total credit-card debt. ... At some point in the not-too-distant future..., College is no longer a good investment. That’s a problem for you and for those who will follow you into these hallowed halls, but it’s also a problem for America as a whole.

You see, a college education isn’t just a private investment. It’s also a public good. This nation can’t be competitive globally, nor can we have a vibrant and responsible democracy, without a large number of well-educated people.

So it’s not just you who are burdened by these trends. If they continue, we’re all f*cked.

Eddie Lazear has an op-ed in the WSJ on the fiscal cliff that, among other things, pooh-poohs any concerns that sudden cuts in spending might hurt the economy. He weasels a bit, but basically conveys the impression that there’s no evidence for Keynesian effects.

What this signifies to me is the politicization and corruption overtaking the economics profession. I’ll give Eddie the benefit of the doubt; he is probably just going by what his friends say. But it’s truly awesome: in the midst of a crisis that has both provided overwhelming evidence for Keynesian views of fiscal policy and inspired a great deal of empirical work that also confirms the case for a Keynesian view, the right wing of the profession is just covering its ears and yelling “La, la, la, I can’t hear you.”

The question of where the moderate, reasonable, rational voices within the Republican Party have gone certainly needs to be examined, but for now let me focus on Lazear's remarks on fiscal policy. What does the evidence actually say? David Romer examines the empirical work on the effectiveness of fiscal policy, notes that there is compelling evidence that fiscal policy works in a major crisis, and says "I think we should view the question of whether fiscal stimulus is effective as settled":

...Given the magnitude and persistence of the demand shortfall in a major crisis and the limited possibilities for policies that shift intertemporal incentives, much of discretionary fiscal stimulus is likely to take largely conventional forms, such as broad-based income tax cuts, increased transfers, and higher government purchases. My second lesson is that the evidence that has come out of the crisis has made the case that such conventional fiscal actions stimulate the macroeconomy even more compelling than it was before.

Because we have had to turn to fiscal tools, the crisis has sparked a great deal of work on the short-run effects of fiscal policy. As Robert Solow stresses in his remarks in this session, we should not be trying to find "the" multiplier: the effects of fiscal policy are highly regime dependent.

One critical issue is the monetary regime. Consider estimating the effects of fiscal policy over the period from, say, 1985 to 2005. Central banks were actively trying to offset other forces affecting the economy, and they had the tools to do so. Thus if they were successful, one would expect the estimated effects of fiscal policy to be close to zero. But this would tell us nothing about the effects of fiscal policy in situations where monetary policymakers are unable or unwilling to offset other forces. Fortunately, there has been a great deal of new research that sheds light on the effects of fiscal policy in settings where monetary policy does not respond aggressively. Some of it uses evidence from the crisis itself, but much does not; some focuses on a particular country, usually the United States, but some uses larger samples; and a considerable body of the work looks at evidence from different regions within a country, again usually the United States. One particularly appealing aspect of this last set of studies is that because monetary policy is conducted at the national level, it is inherently being held constant when one is looking at within-country variation.

Collectively, this research points very strongly (though, I should say, not unanimously) to the conclusion that when monetary policy does not respond, conventional fiscal stimulus is effective. And a careful examination of the evidence gives no support to the view that when monetary policy is constrained, fiscal contractions are expansionary (International Monetary Fund, 2010).

Even so, I find two types of evidence that predate the crisis even more compelling. The first comes from wars. The fact that the major increases in government purchases in the two world wars and the Korean War were associated with booms in economic activity, and that those booms occurred despite very large tax increases and extensive microeconomic interventions whose purpose was to restrict private demand, seems to me overwhelming evidence that fiscal stimulus matters.

The other type of evidence is more general evidence about the functioning of the macroeconomy. We know that monetary policy has powerful real effects, which means that aggregate demand matters. We know that current disposable income is important to consumption. And we know that cash flow and sales have strong effects on investment.It would take a strange combination of circumstances for those things to be true but for fiscal policy, which one would expect to work through those channels, not to be effective. Given this wide range of evidence—not to mention the large body of pre-crisis work on the effects of fiscal policy that I have not even touched on—I think we should view the question of whether fiscal stimulus is effective as settled. ...

Dimon’s Déjà Vu Debacle, by Paul Krugman, Commentary, NY Times: Sometimes it’s hard to explain why we need strong financial regulation — especially in an era saturated with pro-business, pro-market propaganda. So we should always be grateful when someone makes the case for regulation more compelling and easier to understand. And this week, that means offering a special shout-out to two men: Jamie Dimon and Mitt Romney. ...

First,... let me talk about Mr. Romney... Here’s what the presumptive Republican presidential nominee said about JPMorgan’s $2 billion loss (which may actually have been $3 billion, or $5 billion, or more, but who’s counting?): “This was a loss to shareholders and owners of JPMorgan and that’s the way America works. Some people experienced a loss in this case because of a bad decision. By the way, there was someone who made a gain.”

What’s wrong with this statement? Well,... it’s not O.K. for banks to take the kinds of risks that are acceptable for individuals, because when banks take on too much risk they put the whole economy in jeopardy — unless they can count on being bailed out. And the prospect of such bailouts ... strengthens the case that banks shouldn’t be allowed to run wild, since they are in effect gambling with taxpayers’ money.

Incidentally, how is it possible that Mr. Romney doesn’t understand all of this? His whole candidacy is based on the claim that his experience at extracting money from troubled businesses means that he’ll know how to run the economy — yet whenever he talks about economic policy, he comes across as completely clueless.

Anyway,... Jamie Dimon ... has ... been ... posing as a responsible banker who knows how to manage risk — and therefore the point man in Wall Street’s fight to block ... regulation... Trust us, Mr. Dimon has in effect been saying, we’ve got this covered and it won’t happen again. Now the truth is coming out..., even as Mr. Dimon was giving speeches about responsible banking, his own institution was heaping on the risk. ...

The point, again, is that an institution like JPMorgan — a too-big-to-fail bank ... whose deposits are already guaranteed by U.S. taxpayers — shouldn’t be engaged in this kind of speculative investment at all. And that’s why we need ... much stronger financial regulation...

Will we get that kind of regulation? Not if Mr. Romney wins... Even if President Obama is re-elected, getting the kind of regulation we need will be an uphill struggle. But as Mr. Dimon’s debacle has just demonstrated, that struggle remains as necessary as ever.

[T]he growing crisis [the Depression], spurred action on improving employment statistics. In July [1930], Congress enacted a bill sponsored by Senator Wagner directing the Bureau to "collect, collate, report, and publish at least once each month full and complete statistics of the volume of and changes in employment." Additional appropriations were provided.

In the early stages of the Depression, policymakers were flying blind. But at least they recognized the need for better data, and took action. All business people know that when there is a problem, a key first step is to measure the problem. That is why I've been a strong supporter of trying to improve data collection on the number of households, vacant housing units, foreclosures and more.

But unfortunately some people want to eliminate a key source of data ...

Like Robert Waldmann, I have always taught that the Phillips curve was initially promoted as a permanent tradeoff between inflation and unemployment. It was thought to be a menu of choices that allowed most any unemployment rate to be achieved so long as we were willing to accept the required inflation rate (a look at scatterplots from the UK and the US made it appear that the relationship was stable).

However, the story goes, Milton Friedman argued this was incorrect in his 1968 presidential address to the AEA. Estimates of the Phillips curve that produced stable looking relationships were based upon data from time periods when inflation expectations were stable and unchanging. Friedman warned that if policymakers tried to exploit this relationship and inflation expectations changed, the Phillips curve would shift in a way that would give policymakers the inflation they were after, but the unemployment rate would be unchanged. There would be costs (higher inflation), but not benefits (lower unemployment). When subsequent data appeared to validate Friedman's prediction, the New Classical, rational expectations, microfoundations view of the world began to gain credibility over the old Keynesian model (though the Keynesians eventually emerged with a New Keynesian model that has microfoundations, rational expectations, etc., and overcomes some of the problems with the New Classical model).

Robert Waldmann argues that the premise of this story -- that Samuelson and Solow thought the Phillips curve represented a permanent, exploitable tradeoff between inflation and unemployment -- is wrong:

Paul Krugman, John Quiggin and others (including me) have argued that the one success of the critics of old Keynesian economics is the prediction that high inflation would become persistent and lead to stagflation. The old Keynesian error was to assume that the reduced form Phillips curve was a structural equation -- an economic law not a coincidence.

Quiggin and many others including me have noted that Keynes did not make this old Keynesian error... The old Keynesian error, if it occurred, was made later. I have claimed (in a lecture to surprised students) that it was made by Samuelson and Solow. Was it ?

This is an important question in the history of economic thought, because the alleged error serves as a demonstration of the necessity of basing macroeconomics on microeconomic foundations. For a decade or two (roughly 1980 through roughly 1990 something) it was widely accepted that, to avoid such errors, macroeconomists had to assume that agents have rational expectations even though we don't.

The pattern of a gross error by two economists with impressive track records and an important success based on an approach which has had difficultly forecasting or even dealing with real events ever since made me suspect that the actual claims of Samuelson and Solow have been distorted by their critics. To be frank. this guess is also based on a strong sense that the approach of Friedman and Lucas to rhetoric and debate is more brilliant than fair.

I am very lazy, so I have been planning to Google some for months. I finally did. ... I googled samuelson solow phillips curve

The third hit is the 2010 paper by Forder which discusses Samuelson and Solow (1960) (which I have never read). ... Forder quotes p 189

'What is most interesting is the strong suggestion that the relation, such as it is, has shifted upward slightly but noticeably in the forties and fifties'

So in the paper which allegedly claimed that the Phillips curve is stable, Solow and Samuelson said it had shifted up. Rather sooner than Friedman and Phelps no ?

So how has it become an accepted fact that Samuelson and Solow said the Phillips curve was stable ? This fact is held to be vitally centrally important to the debate about macroeconomic methodology and it is obviously not a fact at all. How can it be that a claim about what was written in one short clear paper is so central to the debate and that no one checks it ?

They did caption a figure with a Phillips curve "a menu of policy choices" but (OK this is a paraphrase not a quote)

After this they emphasized – again – that these 'guesses' related only to the 'next few years', and suggested that a low-demand policy might either improve the tradeoff by affecting expectations, or worsen it by generating greater structural unemployment. Then, considering the even longer run, they suggest that a low-demand policy might improve the efficiency of allocation and thereby speed growth, or, rather more graphically, that the result might be that it 'produced class warfare and social conflict and depress the level of research and technical progress' with the result that the rate of growth would fall.

So, finally after months of procrastinating, I spent a few minutes (at home without access to JStor) checking the claim that is central to the debate on macroeconomic methodology and found a very convincing argument that it is nonsense.

If that were possible, this experience would lower my opinion of macroeconomists (as always Robert Waldmann explicitly included).